Government Guarantees And Bank Vulnerability During The Financial Crisis Of 2007 – 09: Evidence From An Emerging Market

Author(s) VIRAL V. ACHARYA AND NIRUPAMA KULKARNI

ABSTRACT

We analyze the performance of banks in India during 2007-09 to study the impact of government guarantees on bank vulnerability to a crisis. We find that vulnerable private-sector banks performed worse than safer banks; however, the opposite was true for state-owned banks. To explain this puzzling result we analyze deposit and lending growth. Vulnerable private-sector banks experienced deposit withdrawals and shortening of deposit maturity. In contrast, vulnerable state-owned banks grew their deposit base and increased loan advances, but at cheaper rates, and especially to politically important sectors. These results are consistent with greater market discipline on private-sector banks and lack thereof on state-owned banks which can access credit cheaply despite underperforming as they have access to stronger government guarantees and forbearance.